Accounting standards for nonprofits are probably not the first thing you think about, but are crucial for your organization to succeed.
Nonprofit organizations distinguish themselves from for-profit entities through their purpose and mission. Their mission is usually anchored on a cause or social purpose, not on the generation of profits.
Because of their unique structure and operational model, nonprofits must comply with various accounting standards that are, in many ways, different from for-profit organizations.
In the United States, these Generally Accepted Accounting Principles (or GAAP) are set by the Financial Accounting Standards Board (FASB). NPOs must adhere to these accounting policies to remain compliant with the law and maintain their tax-exempt status.
The consequences of not adhering to accounting standards can be severe, leading to:
- Inaccurate financial reporting
- Hefty fines and penalties
- Reputation damage
- Loss of confidence from donors and stakeholders
- Funds being frozen or withheld
- Highest risk of failure and even closure
- IRS audits
- And in some cases, the revocation of the organization’s tax-exempt status
Here’s what you need to do to remain compliant:
Understand the Basics of Nonprofit Accounting
Nonprofit accounting is a unique process of planning, recording, and reporting the financial activities of a nonprofit organization. The goal is to create an accurate and comprehensive record of all transactions that can be used for both internal and external reporting, including audits and tax returns.
In the FASB 117, the IRS establishes the core accounting standards for nonprofits, which include:
- Unrestricted, temporarily restricted, and permanently restricted funds
- Fund accounting
- Cash-basis and accrual-basis accounting
- Presentation of financial statements such as statements of functional expenses, cash flow statements & statements of cash flows
- Accounting for donated assets
Ideally, these standards should help your nonprofit maintain transparency and accountability with donors, grant funders, and the public. They also help the nonprofit to allocate their resources properly, keep them organized and only spend on expenses that are essential to the organization’s mission.
This is fundamentally different from for-profit accounting, which is geared towards generating profits and returns for its owners (stockholders). Another difference is in fund accounting. Whereby nonprofits must track their funds separately according to unrestricted, temporarily restricted, and permanently restricted categories.
Section 501 (c)(3) organizations must also adhere to specific tax-filing requirements that are uniquely different from for-profit entities, as outlined in the Internal Revenue Code.
Some of these include:
- File Form 1023 with the IRS to apply for recognition of the organization’s 501 (c)(3) tax-exempt status after incorporation by the state
- File form 990 (990-N for nonprofits with less than $50,000 in annual revenue and form 990-EZ for those with between $50,000 and $200,000) that discloses your revenue, expenses, and changes to net assets
- File Form 8868 to request an extension for filing form 990
- Pay federal tax Unrelated Business Taxable Income (UBTI) that’s more than $1,000
Identify Relevant Accounting Standards
The truth is, you can’t truly comply with accounting standards without first identifying which ones are applicable to your organization.
First, nonprofits must follow GAAP, the Generally Accepted Accounting Principles. GAAP’s main objective is to ensure that all financial information is reported accurately, consistently, and transparently. This includes financial statements such as:
- Income statements
- Balance sheets
- Statements of cash flows
- Statements of functional expenses.
In addition to GAAP, nonprofits must also comply with FASB 117, the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 117 (FASB 117). FASB aims to develop and issue accounting standards through an inclusive and transparent process intended to promote useful information and decision-making by the NPO board, donors, grant funders, and other stakeholders.
There are ongoing efforts to establish International Financial Reporting Standards (IFRS) for nonprofits, which, if successful, could result in greater consistency and comparability of financial information across countries.
The Chartered Institute of Public Finance and Accountancy (CIPFA), together with Humentum, are working to develop these standards under a project titled “International Financial Reporting for Nonprofit Organizations (IFR4NPO)” and has already released an Exposure Draft to establish a framework for their use.
Implement Internal Controls
To ensure compliance with accounting standards, you must have proper internal controls in place. Internal controls are a set of written policies, processes, procedures, and systems of authorization, reconciliation, documentation, security, and separation of duties.
These financial practices:
- Promote accountability
- Ensure the integrity of financial and accounting information
- Help improve operational efficiency by improving the accuracy and timeliness of financial reporting.
- Help protect against fraud, embezzlement, and mismanagement of assets and resources.
Internal controls also provide reasonable assurance that things won’t go sideways and mitigates human error or malicious activities. For example, having one person responsible for recording expenditures and another approving the payments ensures that someone continually monitors all financial transactions.
Other common nonprofit internal controls include:
- Establishing financial policies and procedures
- Implementing an audit process
- Creating a risk assessment process
- Setting up a system for tracking expenses.
- Generating and storing critical supporting documentation
- Segregation of duties (SOD)
- Access rights and roles to critical financial applications
- Multilevel review of financial statements and other reports
- Monthly bank and credit card reconciliations
- Periodic review of vendors receiving fees/checks from the nonprofit
- Background checks for employees and board members
Compliance monitoring is a continuous process of tracking and evaluating data to ensure that your nonprofit complies with accounting standards. This can be achieved by:
- Keeping up with new regulatory developments
- Regularly reviewing financial statements
- Conducting internal audits
- Setting up a process for monitoring compliance
- Evaluating the effectiveness of internal controls, financial policies, and procedures
- Regularly assessing risks and making necessary changes to mitigate them.
- Creating procedures for taking corrective action when necessary.
Depending on the organization’s size, you can have a single person (such as a CFO) or an audit committee to monitor compliance.
Work with Compliance Experts
Complying with accounting standards is critical to ensure your nonprofit’s credibility, sustainability, and stability. But this can be hard, especially if you don’t have requisite accounting experience.
To ensure that your organization is properly complying with accounting standards, it’s important to work with experienced compliance experts, such as The Charity CFO.
Our experts give you an independent, third eye visibility, and objective review of your financial practices to ensure you remain compliant. Our qualified compliance experts can advise you on best practices and provide support to ensure your nonprofit organization follows industry-specific accounting.
Contact us today to learn more about our services and how we can help your nonprofit organization stay compliant for years to come.